|»5 Minute Wrap Up by Equitymaster|
On This Day - 3 FEBRUARY 2011
Read this and you will certainly end up rich!
In this issue:
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Imagine two investors A and B. We assume that investor B starts earning at the young age of 19 and decides to put aside Rs 20,000 every year till the time he turns 26. And that's it. He doesn't invest a penny afterwards. Now, let us consider investor A. Unlike B, investor A starts investing Rs 20,000 only after he turns 26. But does so dutifully every year till the time he reaches 65 years of age. Both of them are assumed to earn 10% per annum on their investments.
Now here comes the real shocker. We know that investor B has made only seven contributions while A has made around 40 contributions towards his portfolio. Despite this, you'd be amazed to know that B will end up with more money than A when both of them turn 65. In other words, while A's money has grown around 11 times, B has been able to grow its money a whopping 66 times.
The above example clearly highlights the magic that the process of compounding works on one's portfolio. Just by letting his money compound over a slightly more number of years, investor B was able to make more money than A even though he made far less number of contributions. And therein lies the biggest secret to becoming rich we believe. Investment returns over a long period are not dependant as much on the amount of money one puts aside. They are more a function of letting compounding work its magic by starting to invest as early as possible.
He believes that fixed investments that now account for 70% of the Chinese economy are now tied to its real estate. We are not surprised to know this given the excessive lending that Chinese banks have resorted to in the past year. But what is worrying is that Chanos predicts a burst in China's realty bubble anytime soon. One that could shrink growth in the world's fastest growing economy. In such a scenario, investors globally would look for safer options in emerging markets. And India could well be the haven if the regulators here keep a strict oversight on bubble like conditions across assets.
Whatever it is, the Indian markets are bearing the brunt of this shift in fund focus. But then the Indian markets were also the ones who witnessed the boom in prices when these funds were pouring money into India. That is the innate problem of foreign fund flows. When they go away, they lead to market falls.
This is exactly what is happening in the US right now. By keeping interest rates at near-zero, the US central bank is robbing today's savers to pay for tomorrow's prosperity (even that's not sure). In fact, if you were to believe Bill Gross, the chief of the world's biggest bond fund, he has criticized the Fed for its policies.
As he has written in his latest note, "A low or negative real interest rate for an 'extended period of time' is the most devilish of all policy tools. And the asset class holder that it affects, or better yet, infects, is the small saver and institutions such as insurance companies and pension funds."
This is criminal. But then, central banks are generally kept out from the boundaries of crime, even if it is done against the poor savers.
The political will also seems to be lacking. Especially when it comes to implementing long term reforms. Indeed, if India's government is able to widen its scale of vision and plan well, it will go a long way in making sure that the country's growth stays on track. Further, the infrastructural activity that takes place has to be after careful planning. It must not be a haphazard attempt that will only provide incremental benefits. Unless, India does away with all such constraints, achieving a consistent 9% growth in the coming years will certainly prove to be a challenging task.
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